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The Ratings Game: Why this cruise stock remains JPMorgan’s favorite as leisure travel keeps roaring

The outlook for cruise stocks is still “more positive than not,” according to JPMorgan analyst Daniel Adam, but given macroeconomic and financial concerns in the sector, not all names are worth buying.

He assumed coverage of cruise stocks Tuesday, keeping an overweight rating on Norwegian Cruise Line Holdings Ltd.

and a neutral rating on Carnival Corp.,
while lowering JPMorgan’s rating on Royal Caribbean Group

to underweight from overweight.

Carnival and especially Royal Caribbean, in his view, are “more vulnerable to near-term ebbs and flows of financial market conditions given the magnitude and timing of future capital commitments (new ship orders, principal payments on maturing debt),” Adam wrote.

His analysis of pricing data indicates that Norwegian should benefit from higher ticker prices at least through next year, while he expects that Carnival could see stable pricing and says Royal Caribbean might see declines.

Norwegian “has a smaller, nimbler, and younger fleet with premium pricing,” he wrote, and though the company doesn’t enjoy the same benefits of scale as its rivals due to its smaller share of capacity, it “has a greater opportunity for growth, which we consider a positive against the backdrop of strong pent-up leisure travel demand and the attractive value proposition that cruise lines offer versus land-based vacation alternatives.”

Adam noted that Carnival’s shares have lagged those of Royal Caribbean and Norwegian so far this year, falling 52% as of the publication of his note, compared with declines of about 22% to 23% for the other two names. That underperformance is “largely justified,” per Adam, in light of factors such as the company’s older fleet and fuel-cost exposure, since it doesn’t hedge prices.

“Despite its challenges, CCL is by far the largest, most diversified cruise line operator, and its combination of high financial leverage and industry-leading scale could eventually result in its share price outperforming in an upturn,” he wrote. “However, for us to get more positive on the stock, we need to be convinced that short-term occupancy gains are not coming at the expense of long-term pricing.”

As for the downgrade of Royal Caribbean, he worries about the company’s greater relative leverage, which could require additional capital raises done either through equity deals or through asset sales.

“At current levels, a $3.5 billion equity deal would be ~20% dilutive to shareholders,” Adam wrote. “In other words, additional equity and/or high interest-bearing debt raises are distinct possibilities over the next 1-2 years.”

Royal Caribbean shares are down 1.8% in Tuesday morning trading, while Carnival’s stock is down 1.0% and Norwegian’s is down 0.5%.

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